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Why the rolling stock OEMs’ model will fail

In the early days of the railway century after the emergence of the first larger rolling stock manufacturers, OEMs had strong ties to the mostly state owned railway operators and maintainers. The result was a strong operator focus. Even though it might have been not economically sound, it allowed the development of many expensive research projects and with this trial and error also many innovations. The fact that most parts of the supply chain where in-house allowed some of the best engineers to develop sound solutions and lay down the path of many innovations we still pursue. In the 90ties, many of the OEMs where acquired by multinationals such as Adtranz, Siemens etc. which was followed by a disinvestment phase of non-core business units. While this has allowed for many specialized companies to emerge in the supply chain and incremental innovation in the respective fields, it has over time also shifted the profitability from the OEM towards the sub-suppliers.

The current business model

Nowadays, the rolling stock OEM’s business model depends on its capabilities as the system integrator and, at least partially, as the car body builder. As the OEM is the general contractor towards the customer, it is also taking the responsibility for the system design while the carbody is the structure with most of the interfaces. The OEM defines the sub-suppliers, purchases these goods from, mostly single sources, integrates them in its assembly plant, carries out the testing, homologation and commissioning. Surprisingly this responsibility and risk is not reflected in the profitability: While many sub-suppliers benefit from net-margins between 10-30%, the OEM usually has somewhere between 5-10%.

Challenging the business model

Only the still highly integrated OEMs such as Bombardier, Siemens, Hitachi and Toshiba could theoretically avoid the margin erosion by cross-financing the OEM activities with its sub-suppliers. However, due to internal policies, these integrated OEMs are mostly required to purchase from its own business units and are therefore less dynamic to react to the customers’ and economic needs of the project.

The system engineering is becoming more and more a core capability. However, the demand for these highly specialized activities fluctuates over time why many OEMs are now depending on external resources similar to the automotive sector. This has increased costs and at the same time increased the frequent loss of capabilities on the OEMs side.

The current business model makes it even harder for an OEM to stand out as most of the supplies are more and more similar. The competition towards the customer becomes more focused on the price instead of technical differences.

Finally, the digitalization of the industry, sensors, data collection and analysis systems requires a strong collaboration between the different sub-supplies. The integrated OEM can theoretically do this within its business units, the other OEMs will invest more and more in coordination activities within its supply chain. However, this will pose the biggest challenge in the next years and the reason why the standard OEM’s model will eventually fail.

Where to go?

The OEMs are in need of strengthening its core capabilities by building up system engineering and digitalization teams. To offer modular product families could, at least on paper, allow to level the demand for these activities and make the OEM more independent from engineering providers while allowing multiple optimization cycles over time, similar to the aviation industry. This means also that the OEM needs to strengthen its ties to the supply chain to shift the risk towards them, share the profit margin and create specific products for the OEM. This creates a virtual integrated OEM which follows the path of the integrated OEM without having the inefficiency burden of the integrated OEM.

Alternatively, the vertical integration of the supply chain to an integrated OEM will most likely persist in the market as it allows more flexibility to share profit within the organization.